What's Driving Cannabis Stock Cronos Group?

The stock price of Canadian cannabis producer Cronos Group (TSE:CRON) has seen a stellar run over the last year, rising from levels of roughly CAD 1.80 in June 2017 to about CAD 9 currently. The uptick in the stock price has been driven partly by Canada’s move to legalize cannabis for adult consumers for recreational purposes and a booming medical marijuana market in Canada. Since this is a relatively new industry, it does have the potential to grow and over time become an established and profitable industry such as the tobacco industry. Consequently, investors may currently be anticipating Canadian cannabis stocks to perform better than the more mature tobacco giants, Philip Morris and Altria. In this note, we take a look at some of the factors driving Cronos Group’s performance and stock price.

Cronos Business

Cronos Group principally produces and sells dried cannabis and cannabis oils in federally legal jurisdictions, including Canada and Germany. The company also has strategic joint ventures in markets including Canada, Israel, and Australia. Cronos operates under two segments, namely the investing division, which makes equity investments in licensed producers in Canada, and the operating segment, which is involved in the production and sale of medical cannabis through wholly-owned subsidiaries OGBC and Peace Naturals.

Recreational Marijuana In Canada

While the company makes the bulk of its money by selling medical marijuana in Canada, its biggest opportunity lies in the recreational market. Canada looks set to legalize recreational marijuana after the country’s Senate recently voted in favor of new legislation. Although there isn’t a definitive date as to when it will be legalized, Cronos has been preparing for the demand growth that would come from the legalization by scaling-up its production capacity. For instance, the company is scaling up its Peace Naturals indoor facility, while building a greenhouse in Israel and another indoor facility in Australia via a joint venture. While the company only had about 6,650 kg of capacity at the end of last year, it has estimated that its annual production capacity will top 47,000 kgs by early 2019. The company is also set to open retail stores for the sale of recreational marijuana in Canada, via a joint venture with U.S based company, MedMen.

Other Growth Avenues

The company is also seeing some other avenues for expansion. For instance, the company has inked a 5-year exclusive distribution agreement with G.Pohl-Boskamp, which will allow the company to distribute its product to over 12,000 pharmacies in Germany, which is currently the largest cannabis market in the world. The company is looking to increase the mix of its sales that come from cannabis oils, which are more lucrative compared to dried cannabis. About 9% of its total Q1 sales came from cannabis oils up from zero in the year-ago period. The company is also working on a new oil extraction lab, which will allow it to create new cannabis tinctures, ointments, and capsules.

Valuation

The company’s revenues have been growing at a healthy pace, albeit from a very small base. In 2016, revenues stood at CAD 554k and the figure grew to about CAD 4.1 million in 2017. The company is projected to see sales of about CAD 32.63 million in 2018, and about CAD 154 million in 2019, according to the consensus estimate from Reuters. The company is currently valued at about CAD 1.6 billion, or about CAD 9 per share, which translates into a price to sales multiple of about 10.5x based on 2019 revenues. We have created an interactive dashboardanalysis which allows users to modify the company’s forward revenues and multiple to arrive at a valuation estimate for the company.

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